Setting Up a 401k for a Small Business

A 401(k) plan is a common, simple way for workers to save for retirement. Usually, they sign up through their employer, choose how much of their income they’d like to contribute, and their retirement savings grow exponentially over the following decades.

As a small business owner, you might feel at a disadvantage. After all, setting up a 401(k) for your employees takes time, connections, and a healthy budget, right?

In actuality, providing a 401k for your employees is easier than you think. And, while they certainly come at a cost, there are enough options that you can likely find one that fits your budget.

So, let’s talk about how you can set up a 401k as a small business, why offering one could benefit you, and how much it might cost.

Benefits of a Small Business 401k

Offering a 401(k) to employees comes with many benefits. For small businesses, it can provide additional benefits in the form of tax cuts and deductions. Offering a 401k as a small business allows you to:

  • Attract and retain talented employees
  • Claim tax credits of up to $16,500 (over three years) when starting a new plan
  • Earn an employer contribution credit of up to $1,000 per employee (for businesses with up to 50 employees)
  • Become eligible for additional tax deductions
  • Pick from many affordable options
  • Provide flexible retirement savings options for employees

How much does offering a 401k cost?

The costs associated with offering a 401k can vary greatly. It can depend on how big your business is, what your plan administrator offers, and the specific features you want to provide your employees.

There are three categories most 401k costs fall under. Those are:

1. Startup costs

Startup costs can range anywhere from $500 to $2000. That’s a wide range, so consider researching providers and what they offer to help you narrow that figure down.

I’d also recommend researching if you qualify for any tax credits. Under the SECURE Act, businesses with fewer than 100 employees could be eligible for a credit of up to $5,000 yearly for the first three years they offer the plan. There could be an additional $500 tax credit for those three years. That’s a potential $16,500 in credits to help offset the costs of starting a 401k plan for your employees.

2. Administration fees

A 401k plan requires day-to-day handling and maintenance. Typically, your plan administrator will handle these tasks. Unfortunately, that requires additional costs.

The administration fees associated with your plan will vary depending on the specific features you choose to offer your employees. The more complex a plan you offer, the more it costs to maintain.

These fees can also have a wide range—anywhere from $750 to several thousand dollars each year.

You’ll probably also have to pay a fee for each plan participant (each employee enrolled in the plan). These fees are small—usually between $15 and $60 per enrolled employee per year.

3. Employer contributions

As far as 401k costs go, employer matching contributions are the ones you have the most control over. Through such a program, the business contributes a matching percentage of each employee’s contribution directly to their plan. It’s free money for the employee, but offering it helps your business remain competitive in the job market.

How much you contribute is entirely up to you. However, there are limits to the percentages you can offer and the total amount you can contribute to each account. The percentage you’re allowed to match can vary, but most businesses can match up to 25% of each employee’s salary. The total dollar contribution limit goes up every year. In 2023, an employer can contribute no more than $66,000 to an employee’s plan.

However, most employers match a relatively small percentage of their employee’s contributions. Usually, it’s somewhere between 4-6%. Though that might sound like a small amount, it builds up over time and can still offer many advantages to your employee’s retirement.

How to set up a 401k for your employees

Setting up a 401k for your employees is a simple process. Of course, there’s plenty of paperwork. But otherwise, it’s relatively painless. It generally consists of making a series of important decisions that guide how the plan you offer will work for your employees.

The steps for setting up a 401(k) usually look like this:

Find your provider

This usually entails shopping around online for a provider that offers what you need at a price you can afford. You may need to contact them directly to learn specific pricing details. It could take time to find one that works for you. However, getting closer to what you need with this first step can help give you a positive experience for the rest of the process.

Choose the type of 401k you’d like to offer

There are several types of 401k plans to choose from. For example:

  • Traditional 401k
  • Roth 401k
  • Safe harbor 401k
  • SIMPLE 401k

Each comes with its own advantages and costs. For instance, a traditional 401k’s contributions are tax-advantaged. This means your employees don’t pay taxes on the income they contribute to their plan. However, those taxes are only deferred—they’ll have to pay them whenever they take a distribution.

On the other hand, contributions to Roth 401k plans are made with after-tax dollars. Your employees must pay taxes on that income before it gets contributed. However, once they retire, they can receive their distributions tax-free.

Most employers offer traditional, target-date 401k plans because they’re solid and flexible. You might consider asking your employees what they want from a retirement plan. Your plan provider can also discuss the details of each with you to help you make your decision.

Outline specific details of the plan

This is where you pick what features you’d like to offer. For instance, you can decide your contribution match percentage or whether you’ll offer automatic enrollment. You can also set a vesting timeline outlining when your employees become fully vested in their plans.

There are many details to iron out. Again, your plan administrator can talk you through them to discuss the advantages and costs of each feature.

Set up a trust and assign a trustee

This step is legally required for all qualified retirement plans. By putting the funds into a trust, you’re ensuring that those funds exist and will only be used as retirement benefits. By assigning a trustee, you’re putting someone in charge of the maintenance and distribution of those funds.

Usually, both the trust and trustee will be a bank or other financial entity. However, you can assign any individual, group, or committee you like to be trustees.

Write up a plan document

This is another legal requirement. Usually, the plan document outlines the rules, offerings, and features of your 401k plan, along with how your employees can contribute to their plans. This serves as legal proof that you’re using the plan the way it’s intended to be used.

Typically, your plan administrator will write this up for you. If so, consider looking it over to ensure it accurately reflects the plan you’ll be offering.

Then, you’re ready to sign up your employees!

Things to consider when offering a 401k

Form 5500

Once you offer any qualified retirement plan to your employees, you’ll need to file Form 5500 annually. Form 5500 is a legal form that shows the government details of the 401k you offer, how it was used, and what contributions were made.

There are different versions of Form 5500. Which version you file will depend on the size of your business. The different versions are:

  • 5500-SF: For small businesses with fewer than 100 employees
  • Form 5500: For large businesses with more than 100 employees
  • 5500-EZ: For one participant plans (usually for self-employed business owners)

Other retirement plans

A 401k isn’t your only option for offering a retirement plan. There are many choices out there, such as:

  • 403(b) plans
  • 457 plans
  • SIMPLE IRA plans
  • Profit-sharing plans
  • SEP plans
  • Employee stock ownership plans (ESOP)

Each comes with its own benefits, costs, and considerations. As always, I recommend performing preliminary research to determine which works best for you, your business, and your employees.